Is there really margin relief on the horizon?

One of the headlines in the 1st quarter 2007 FDIC Quarterly Banking Profile reads, "Margins Fall to Sixteen-Year Low at Smaller Institutions". Indeed the flattening yield curve has placed tremendous pressure on bank margins. Our own peer data shows that, for banks <$100M in total assets, average Net Interest Margin is 4.29%, 10 basis points lower than one year ago.

"For small community banks, the flat yield curve has left little room for margin in what is essentially a margin business," notes the CFO from a small community bank in the Pacific-northwest. On average in the 2nd quarter of 2007 the difference between the 1-month treasury yield and the 30-year yield is only 21 basis points. Over the past ten years the average difference has been more like 190 basis points.

The relationship between the Fed Funds rate and the 1-Month yield is causing some heartache too. For the 2nd quarter of 2007 the difference was 47 basis points. Three years ago when Fed Funds was at its lowest point in years, the difference between the Fed Funds rate and the 1-Month treasury was only 6 basis points.

Recently, most community bank's have been able to ease margin pressure somewhat by limiting increases in their core transaction deposit rates. I blogged about this two-months ago. Looking at the data for 1st and 2nd quarter of 2007 it looks like the trend is continuing.

Small banks continue to keep their core rates low in comparison to Fed Funds.

So what does the future of Net Interest Margin look like? With central banks once again spooked by inflation pressures, we may see rates rising again (nobody guessed that a year ago!). In that case there will be continued upward pressure on core rates, so margins are likely to fall.

What if rates start to fall again? Unfortunately it looks like margin pressure is waiting there too. Bank's have much less wiggle-room here than ever before. You can't lower rates that never went up in the first place.